Dear Reader,
The holidays are upon us once again – which means friends and family gathering for some great food and fun.
It also means there may be some spare time to review brokerage statements, ponder what’s happening in our economy and ask the question: What in the world has happened to my investments this year and how will I ever keep up under these conditions?
You’re not alone and your concerns are valid.
The Fed is struggling to significantly lower our inflation rate and since last month’s reading was nearly unchanged, Americans are going to pay for it out of their own pockets.
With sustained, high inflation levels such as we’ve reached this year, it could cost Americans an average of $500 per month more just to keep up with their current lifestyles.
So, I’ve got a strategy to share with you that can make money even if the stock’s price doesn’t rise a penny on you.
It’s called a vertical spread trade, and it’s not only easy to put together, but you’ll be surprised about how many ways you can profit with it.
The vertical spread simply combines two option contracts into one trade.
Buying a call option to profit from rising stock prices is one of the simplest ways to profit with options, but there’s a way to cut down on the cost of a single option trade and still be profitable – create a vertical spread.
The vertical spread gets its name because we’re buying an option and then selling an option with a different strike price, but with the same expiration date.
Take a look at the image below to see what a bullish call vertical spread looks like:
You can see from the example above that both options have the same expiration – November 11, 2022. In addition to buying the $111 call option, we’re selling the $114 call option – which is how a vertical spread trade is created.
In our example trade above, we paid $10.98 for the $111 option, but then brought in a credit of $9.33 for the $114 contract we sold – this creates a net debit of $1.65 per share, or $165 per contract, which also means it’s the most we would expect to lose on this vertical spread should it turn sour on us.
Now, calculating our profit potential for the bullish call vertical is easy – Simply take the difference between your two strike prices and subtract out your net debit ($3 – $1.65 = $1.35 profit potential).
Just keep in mind that for bullish verticals spreads the stock’s price must trade above both strike prices in order to achieve maximum profit of $135 in this case. If the stock falls below both strike prices at expiration, we can experience the maximum loss – $165.
You’re In Control of The Vertical Call Spread Risk and Reward
When it comes to rewards, risks and probabilities associated with the vertical spread, it’s your choice.
Let me illustrate what I mean.
I’ve constructed three different vertical call spreads on ETSY in the image below: Verticals A, B and C.
Since ETSY is trading at $114.94, let’s consider the reward and probability of each vertical spread choice – the probability and reward will vary for each vertical, based on its proximity to the stock’s price.
Vertical Spread A
Take a look at vertical spread A. My strikes selected for vertical A are $120 and $117 which are above the stock’s current trading price, so ETSY must rise higher and trade above $120 by expiration to achieve the maximum profit potential.
Since the stock is required to rise for vertical A to achieve its maximum profit, it would be considered a lower probability, higher reward trade. Lower probability because the stock’s price must move higher, but higher reward because the stock’s price has to work harder to get you to profitability.
Vertical Spread B
For vertical spread B, the stock is trading just above the strike prices ($114 and $111) – this would be considered a medium probability, medium reward trade. Because the stock is already above both strike prices, it can stay flat or rise for this vertical to be 100% profitable – whether the stock remains flat or rises it’s amazing because the trade can be profitable in the end even if the stock’s price doesn’t move a penny.
Vertical Spread C
A third option would be to create a vertical spread well below the stock’s current trading price. In this example, vertical spread C fits the bill – ETSY is already trading well above both strike prices: $105 and $102.
And, since the stock is already well above the strike prices of vertical spread C, it would be considered a lower reward, higher probability trade – the stock’s price can rise, stay flat or even drop a little for this spread to be 100% profitable.
One of the things I love about the vertical spread option strategy is the choice is yours – you’re in charge of creating anything from higher reward trades to higher probability trades.
In fact, this type of strategy is appealing under the current economic situation we’re subjected to – these trades can be used to capture profits and make up for some of the buying power we’ve lost due to such high inflation.
I’ve worked with this strategy for decades and you’ll find me talking about it routinely in my Live sessions each Monday, Tuesday and Wednesday.
Join my free sessions to expand your knowledge and find new trading opportunities.
Until next time,
Tom Gentile
America’s #1 Pattern Trader
Join Tom each Monday through Wednesday at 12:00 p.m. ET as he discusses a range of strategies to make money in a strained market environment.
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